Most people are unaware their social security benefits can be taxed. Maybe it’s because they don’t think about it; they think they’re too young or they just don’t fully understand the effect of these taxes. Fortunately through proper retirement distribution planning either some or all of these taxes can be eliminated based on a person’s situation.
But first, let’s discuss social security benefits.
Interestingly enough, there are currently more than 1,000 different ways for married couples to draw these benefits. This number sounds overwhelming and it is likely another contributor as to why many don’t know or understand their taxes.
As to which one is best for you and your spouse can only be determined after a thorough financial analysis of your situation. There’s no shortcut for this and once you have decided which method to go with, your work has just started.
Next up is to match the most efficient investment distribution plan to minimize the taxation on your social security. Let’s crunch some numbers that are relevant at the time of this writing.
- If you are a married couple and your calculated income is over $44,500, then 85% of your social security income will be taxable.
- If your calculated income is $33,000 to $44,500, then 50% of your social security income will be taxable.
- If it is below $33,000, then your social security income will be tax free.
Here at Centorbi Financial, we can help clients with this. Let’s use Joe and Jane Smith as an example of a couple with a calculated income of more than $45,000.
The Smith’s income need is $40,000 annually and they currently have combined social security benefits of $20,000 annually, $22,500 in annual pensions and investments paying them 5%. Their taxable investment, such as a CD or mutual fund, is valued at $350,000 and the interest they receive is $17,500 annually.
This all comes out to a $60,000 (20,000 + 22,500 + 17,500).
Now the way the IRS calculates your taxable base to determine the percentage of taxable social security, is they take all income sources (except Roth IRA’s) plus half of your social security benefits. The Smiths will have a $50,000 calculated income (pension income of $22,500 + $17,500 interest + half of social security benefits at $10,000).
As they’re above the $44,500 mark, their total income would be $60,000 with $58,500 being taxable.
At issue here is the Smiths are paying taxes on the interest that they do not need and are not using. If they transferred their taxable investment into an annuity, either a fixed or variable one, they would receive an immediate tax deferral from that point forward. They would also have guaranteed income since all of the income is tax deferred until there is a distribution.
Let’s look at their tax situation again, this time by including an annuity.
The Smiths would have the same $20,000 in social security benefits and the same $22,000 in pension benefits. Now, let’s assume the annuity is earning the same 5%. This would give them $17,500 of interest again, but the difference would be that it is deferred, not taxable in the year it is earned.
In addition, their total income and interest would again be $60,000. The calculated base for social security would be $32,500 ($22,500 from pensions + half of social security benefits at $10,000). Since this would be below the social security base, their social security income would not be taxed.
Of the $60,000 of interest and income, they would only be paying taxes on $22,500 of pension benefits. That is a reduction in taxable income of 62% ($58,500–$22,500/$58,500).
And just think, all of this just came from the inclusion of either a fixed or variable annuity.
To see how this strategy could work for you, please give us a call at 866-200-Retire or send us an email: firstname.lastname@example.org.
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